Northern Exposure

In the business world, the rearview mirror is always clearer
than the windshield.
-Warren Buffett

Reading our papers and looking at our markets, it is hard to be
anything but gloomy. We now have irrefutable evidence that the new
administration does not have a magic wand. If anything, they seem
to be afflicted with the same communication challenges as the
previous administration. While we wait for the stimulus package to
pass and the financial rescue package to take shape, the financial
sector remains in turmoil, jobs are being lost at a record pace and
housing remains in the doldrums.

However, the picture is not quite as bleak everywhere. Clearly,
most nations have been impacted by the U.S. led slowdown and the
resultant demand destruction. Economies like Taiwan, which are
heavily export dependent, have slowed dramatically, while most of
Eastern Europe is struggling as well. However, there are glimmers
of hope in China, possibly India and even Brazil. In China, for
example, even though imports and exports have been impacted by the
global slowdown, retail sales, industrial production and the PMI
indices are showing resilience. That is not to say that a rebound
is on the horizon; however, maybe the pace of decline is slowing,
and if that turns out to be the case, the economy could bottom
sooner than most expect, which would be an unexpected but welcome
boon for the global economy.

The main downside drivers of this recession were housing and the
banking industry. They in turn generated a series of byproducts,
notably de-leveraging, risk aversion, unemployment and falling
demand by both businesses and consumers. As the recession worsened,
its impact spread to most regions of the world.

In Asia, banks have been impacted minimally by the housing
correction and losses on structured assets. In many of those
countries, consumer savings rates are high while debt is low.
Therefore, the problems that they face are for the most part
external in nature and the best defense is a cushion in the form of
domestic demand. On a relative basis, that favors countries like
China and India and hurts Taiwan and the Philippines, though
arguably all of them have an advantage over us. Brazil enjoys many
of the same benefits; despite the price declines in commodities and
energy which hurt the economy, there are reasons to be more upbeat
about Brazil than many other parts of the world.

The message here is that the drivers for recovery in each country
or economic region will include domestic demand and external
perceptions about the future of the region. Countries enjoying
balance of payment, budget and trade surpluses will do better, as
will those with high savings rates and better growth prospects. The
ones that will struggle are those that will take time to work
themselves out of the morass of deficits and sagging domestic
demand. Everyone knows by now that decoupling is generally a myth,
but while absolute economic growth might remain subdued until the
U.S. economy bottoms, relative growth rates could differ widely.

When markets recover, recovery tends to be led by equities and
other risky assets. Equity markets focus on forward-looking
indicators and often start rallying two or three quarters ahead of
an economy coming out of recession. With an increasingly global
economy and plenty of cash on the sidelines, investors have many
choices. I believe those investors willing to invest in overseas
markets will begin to see signs well ahead of the U.S., though they
may be sporadic and unreliable at first. When that happens, expect
those markets and currencies to lead the global recovery, while our
markets and the dollar lag.

Looking Ahead

Not much has changed in the two weeks since I last wrote this
column. Most major currencies have been in a range, except for the
JPY, which is slightly weaker. Asian and Latin American emerging
market currencies have shown some stability as their equity markets
have performed somewhat better, while Eastern Europe continues to
be in turmoil. This relative stability and improved performance of
risky assets reflects a degree of optimism about the resilience of
the "BRIC" economies (ex-Russia) and others. While they have
undoubtedly been impacted by the global recession, their underlying
fundamentals remain sound and there are reasons to believe they
will start growing sooner and at a faster rate than most developed
economies.

For now, hedging most payables and receivables is the conservative
approach in this time of uncertainty. As I said above, I believe we
will see more differentiation in economic and currency performance
as the year unfolds. The U.S. and the USD will lag, followed
closely by the Europe and the EUR. The JPY has benefited from risk
aversion and capital flows, largely an unwinding of carry trades.
However, the economy is in terrible shape and the bounceback likely
to be slow or nonexistent, which argues for JPY underperformance
over time.

As time goes by, it would be wise to pay increasing attention to
currency payables, with a focus on emerging markets. When the
global economy finally recovers, we could possibly see a multi-year
trend of emerging market outperformance of the developed world -
that is, for the most part, where growth, savings and capital
surplus resides.

In the business world, the rearview mirror is always clearerthan the windshield. -Warren Buffett

Reading our papers and looking at our markets, it is hard to beanything but gloomy. We now have irrefutable evidence that the newadministration does not have a magic wand. If anything, they seemto be afflicted with the same communication challenges as theprevious administration. While we wait for the stimulus package topass and the financial rescue package to take shape, the financialsector remains in turmoil, jobs are being lost at a record pace andhousing remains in the doldrums.

However, the picture is not quite as bleak everywhere. Clearly,most nations have been impacted by the U.S. led slowdown and theresultant demand destruction. Economies like Taiwan, which areheavily export dependent, have slowed dramatically, while most ofEastern Europe is struggling as well. However, there are glimmersof hope in China, possibly India and even Brazil. In China, forexample, even though imports and exports have been impacted by theglobal slowdown, retail sales, industrial production and the PMIindices are showing resilience. That is not to say that a reboundis on the...Read More